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Is Offshoring a Problem for the U.S. Economy?

The recent policy debate regarding the American labor force has already found its way into the political posturing of the campaign cycle. The debate is serious: Will offshoring, the practice of outsourcing American service sector jobs to foreign countries, benefit the economy or lower American workers’ wages, hollow out the American job market, and destroy the American service sector? Unfortunately, like many debates in the political world, it has been marred by misinformation and hysteria. Knee-jerk political actions bordering on protectionism that could threaten the growing economy have been proposed. Yet a careful study of the facts shows the hysteria surrounding the effects of offshoring is just that, hysteria.

First, the American labor market has faced the pressures of a competitive global labor market in the past and has only strengthened. At the turn of last century, 40 percent of the American labor force worked on farms. Today, only 3 percent of Americans work on farms while the American agricultural sector outproduces all but 2 countries. At its employment peak in 1979, the American manufacturing sector employed 19.5 million people. Today, the manufacturing sector in America employs 14.5 million people. Over the same time period, its output has increased by 80 percent, making America the largest manufacturing economy in the world, valued at $1.9 trillion in 2002. Even with the decline in the manufacturing sector since 1979, total U.S. employment grew by about 40 million jobs over the same time period.

Second, productivity in the service-sector has rapidly increased in recent years. A report by economists Jack Triplett and Barry Bosworth of the Brookings Institution found the productivity of the service sector has increased at a rate equaling the productivity gains of the manufacturing sector. A report published by the Federal Reserve Bank of Chicago shows the service industry is now reaping the benefits of past investments in the IT sector and these benefits will continue into the future. Such productivity gains strengthen the economy and the labor force as a whole. American workers are already the most productive in the world and companies thinking of offshoring jobs to foreign countries have to calculate whether the savings in lower wages abroad outweigh the loss in productivity.

Third, the American labor force is one of the most flexible in the world, allowing for displaced workers to find jobs elsewhere in the economy. Even during periods of extensive growth, the U.S. economy sheds hundreds of thousands of jobs a year. During the height of economic expansion in 1999, the economy shed 2.5 million jobs but still recorded a net job gain of 1.13 million. The U.S. labor market is growing again, and a flexible labor force allows dynamic job growth.

Fourth, the U.S. software and service sector is not in decline. The U.S. Bureau of Labor Statistics reports eight of the ten fastest growing occupations between the years 2000-2010 will be in computer related fields and all ten will be service sector jobs. Two of the ten occupations with the largest job growth during the same time period will be computer related, including software engineers. The industry with the fastest wage and salary employment growth during the same time period is computer and data processing services.

Certain jobs within the service sector will be lost as companies look to avoid higher labor costs, higher taxes, and excessive government regulations not found in places like India, the new hotbed for IT offshoring. Jobs that will be lost are lower level service jobs like application development, legacy maintenance, and call center operations. Still with these losses, a new study by the London-based analyst firm Datamonitor predicts only 5 percent of the estimated 4.78 million call center agent positions worldwide will be located offshore by 2007. IT workers who require close contact with their businesses will be retained by companies. These include workers in strategy development, business process improvement, and those who work in the application of IT to the business.

Factors other than lower foreign wages must be considered before a business decides to go offshore. Despite direct wages being as much as 80 percent lower in India than in the U.S., a report from Deloitte Consulting shows the total labor cost savings are only 10 to 15 percent because of higher travel costs, communication costs, equipment costs, baseline costs, difficulties in keeping staff levels and service requirements at high enough levels, privacy protection, and difficulties in managerial and oversight. Companies must also weigh the cost of relocating a previously outsourced labor force because of unforeseen expenses and the outsourced business producing lower quality service than an in-house employee. Geopolitical risks are also a factor. When all factors are considered, the U.S. has the built-in advantage of being a capitalist democracy that encourages innovation and research while other countries do not have the infrastructure or social institutions to do so.

Offshoring will lead to lower business costs and lower prices for businesses, increasing the ability for U.S. business to expand and provide new jobs. Additionally, extra income generated abroad by the increased demand for U.S. goods or foreign investment will benefit U.S. exporters and lead to additional jobs and higher wages for the U.S. economy.

Whole classes of high-wage service sector employees will not disappear because of offshoring. American policy makers should restrain from implementing policy that will be detrimental to American businesses and workers. Economic freedom brings economic growth and both businesses and workers will benefit. Restricting offshoring will actually cost American jobs and economic growth, and will raise operating costs for U.S. businesses struggling to compete in a global marketplace.